Not surprisingly given the weight of national aspirations iron ore has carried since the global financial crisis, there is a disproportionately fretful focus on the latest price gyrations triggered by China’s latest bout of economic uncertainty.

That there is reason to be alert and even alarmed cannot be questioned. Not only did physical iron ore prices drop $US10 to less than $US104 a tonne over one dark trading session, but April swaps traded down to $US100 a tonne as traders recovered memories of the great iron ore bungy jumps of late 2008 and 2012.

We only have to think back to September 2012 to understand that big and precipitous slides in iron ore prices certainly can have a very material impact on sustainable life in mining.

Back then iron ore slipped briefly below the $US90 tonne threshold on the back of a significant build-up in stockpiles at the major Chinese iron ore ports and a sudden collapse in demand triggered, in part, by official intervention to cool an overheated domestic economy.

The result, rather famously, was panic stations at Australian iron ore’s third force,
Fortescue Metals Group
. Because, as it turned out, the heavily indebted Fortescue did not make money at those prices and it seemed the only people more surprised than the market about that worrying fact was company management.

Today Fortescue’s all-up break-even number is in the low $70s a tonne and likely heading further south as its lowest cost operation, the Solomons hub, continues its ramp-up to full production of 60mtpa.

Like the rest of the industry, Fortescue’s significant achievements in self-help through cost management and productivity enhancement have been assisted by the 12 per cent re-rating of the Australian dollar against the US dollar in which iron ore, and the rest of the minerals and metals commodities, is actually priced.

The share price stress endured over recent days by miners exposed to iron ore production expresses a concert of quite reasonable concern over short-term demand-side pressures and the medium-term supply side outlook.

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Investors shocked

But investors appear more shocked than they should be about China’s less-than-stellar February import numbers. Sure, they were softer that the excessively strong January number. But looks can be deceiving, particular during Chinese holiday periods.

According to preliminary Chinese customs data, China imported 148.07 million tonnes of iron ore during the first two months of 2014 and that is actually up 21 per cent on the same period last year.

Landings through a February that included the Lunar New Year holiday period totalled 61.24 million tonnes. That was nearly 30 per cent short of the January numbers, but up 8.5 per cent on an annual basis.

Most critically for the outlook, according to China’s steel industry association, CISA, the daily crude steel output, rebounded over the last eight days of February to hit 2.0817 million tonnes a day.

Back in February, after announcing Fortescue’s $US1.7 billion interim result, chief executive
Nev Power
called out 2.1mt a day as the threshold to some form of market equilibrium that allowed him to forecast iron ore prices would range between $US100 and $US120 through the balance of 2014. And even with this week’s trauma, that forecast still looks reasonably prescient.

The longer iron ore story, on the other hand, is rather more uncertain.

In its latest annual iron ore report, Citi Research forecasts prices will decline to an average $US80 a tonne in 2016 and rebound only modestly to $US90 in the years beyond that.

Still in the money

The fact is, of course, that the vast bulk of Australian iron ore production remains attractively in the money even at that sort of depressed price range. So, while profit outlooks might be redrafted if iron ore continues to track at these lower climes, there is nothing life-threatening in even an enduring downshift of prices.

But the implications of weaker for longer pricing outlook for iron ore’s lesser lights, let alone those still attempting to manufacture a place Chinese steel’s still rising sun, are rather more bleak.

Having identified that previous price shocks did very little to trim either existing production or investment ambitions, Citi annual review noted that the risk to the new project pipeline was now pretty high.

Citi called out Gina Rinehart’s $US10 billion Roy Hill project and Sino Iron’s adventure in WA magnetite as being two currently live greenfields opportunities that would be left vulnerable by a longer term reversion of pricing to more traditional ranges.

The Citi view is that the iron ore price will be range-bound under $US90 a tonne right though to 2020 as the sector moves into structural oversupply on the back of increased output from Australia and Brazil. And, frankly, you will not find many among the majors who want to openly disagree with the fundamentals that inform the Citi thesis.

BHP Billiton’s in-house position is that the iron ore market will go into surplus from the end of the 2014, that this imbalance will endure for some time as demand catches up with supply and that prices will be lower and less volatile as a result.

There are some convincingly logical threads to this investment story.

First, there is a conviction that the supply side imbalance will not persist and that, at very worst, market equilibrium will be recovered at some point through the decade-long cycle to China’s peak steel production.

While they disagree on the timing, the majors continue to hold the line that China’s steel production will top out at 1.1mtpa, which represents an increase of about 20 per cent over current output.

To feed that, China is going to need to import more iron ore. Again, there is considerable debate over just how much more iron ore will be needed.

The known unknown here include how much scrap steel might replace China’s raw steel production and how China’s ambition to foster new sources of supply might force structural change to the supply side of the market.

Questions over India

There are questions too about how long India might stay out of the export market. In 2012, it shipped 100mt into the global system. But export controls left that number at 15mt last year. No one thinks that situation is going to endure.

And there are questions too about China’s own iron ore production. Citi noted that while average production costs in China have risen, grades have plummeted. At the turn of the century, China was mining about 30 per cent grade iron ore. It is mining 16 per cent product now. For the record, Australian producers market to a 62 per cent and 58 per cent pricing benchmark.

But Citi questions too, the presumption that high cost and low grades necessarily translates to a rational reduction of production.

It notes that 70 per cent of China’s domestic production is owned by steel makers and thus it might endure.

But the major’s have already laid their bets.

To fill the anticipated demand void, iron ore’s four majors plan to add about 450mt to the system by 2017 or so.

To put that into some sort of context, in 2012, the big four produced 788mt which represented near 70 per cent of the global seaborne trade in iron ore.

So why would the big four producers (Rio, BHP, Fortescue and the biggest of them all, Vale of Brazil) pump new capacity into a market so close to surplus and already so obviously vulnerable to price shocks?

Isn’t this a classic case of what so irritates
Glencore
’s
Ivan Glasenberg
about the indulgent investment practices of his new peers?

Well, to some degree, yes it is. But as Citi’s research makes abundantly clear, the capacity load-up is financially rational even at the firm’s long-range price forecasts.

Big iron ore’s conviction is that the quality and size of the resources they command – mineral deposits, the existing mines and the logistical infrastructure that supports them – leaves them with an embedded and still growing cost advantage over existing peers or potential newcomers.

The way the big four see it then, the current investment program sees them add cheaper tonnes to their systems and that leaves them able to command a greater share of the expanded market while, at very least, sustaining margins.